February 4th, 2016

Rating Agency Developments

Posted at 1:00 AM ET

There is a great deal of overlap between the requirements of government regulators and credit rating agencies. The difference, however, is in the objectives of those requirements, with regulators focused on solvency and ability to trade, or not, and the rating agencies taking it a step further to opine on relative financial strength. Regulatory solvency approval can be viewed as a “qualifier” or minimum standard required to be considered by a customer. A credit rating, on the other hand, can act as a “differentiator” to distribution channels and insurance buyers ultimately leading to greater potential sales opportunities.

Given their impact on customer buying decisions, international rating agencies are able to quickly influence boardroom discussion around topics such as emerging risks, enterprise risk management (ERM) best practices and catastrophe analytics. Currently, the capital and management sophistication levels needed to obtain a strong credit rating are escalating. As (re)insurance buyers continue to value the claims-paying ability of their trading partners, rating agency standards will continue to push insurer ERM and capital adequacy innovation further.

United States

A.M. Best has hosted several Webinars in 2015 to share their proposed changes and preliminary observations related to their efforts to upgrade the Best’s Capital Adequacy Ratio (BCAR) capital model to include stochastic-based analysis. The rating agency has completed internal testing of the stochastic-based BCAR model and is in the process of updating its overall rating methodology, both of which are expected to be announced at the end of the first quarter of 2016, with a goal to implement the new model in the second quarter of 2017 using year-end 2016 data. It is important to note that A.M. Best will not finalize its stochastic BCAR model and overall rating methodology until the comment period closes and all comments are reviewed.

A.M. Best plans to establish consistent Value-at-Risk (VaR) metrics across risk components (investments, interest rate, credit, loss reserves, underwriting) tied to a company’s rating level and implied security standard. While difficult to predict the final outcome of these changes directionally, it is anticipated that risk factors will increase.

The methodology of the property/casualty (P&C) BCAR calculation is expected to remain the same, with the exception of “Potential Catastrophe Losses,” which will be moved to the numerator from the denominator. The expected impact of this change would be to reduce BCAR scores for catastrophe-exposed companies.

We have ranked the P&C risk components based on what we believe will be the relative impact to companies of potential changes to capital factors and required capital:

regulatory_impact-chart1

In addition to the quantitative changes in the BCAR model, A.M. Best continues to place an emphasis on ERM. Increasingly, a well-defined risk management framework with board of directors oversight is the baseline standard expected from companies seeking a rating.

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